The problem to be solved is the inadequacy of Excel spreadsheet technology, and that of the spreadsheet in general, in the Predictive Financial Economic Analysis, used in the analysis of Real Estate Crisis, due to the level of approximation and error and therefore reliability of the processed Financial Economic Reality, which is, in the best of cases, around 15-20%.
This type of approximation highlights a problem not only economic but also of social and ethical responsibility for the consultant, the entrepreneur and the community, which can no longer be ignored.
TO WHOM IT IS ADDRESSED
We target the following types of Investors:
- Private parties
- Institutional Investors
- Unlisted Funds
- Listed Real Estate Companies and Funds
- Banks, Insurance Companies
- Public Administration
- Consulting Companies
Type of Real Estate
The Real Estate assets we target are:
- Land and Areas
- Industrial and Logistics
- Agricultural Properties
- Properties with special allocation of uses
- Public Buildings
Real Estate: definition
The Real Estate sector is commonly divided into three main segments based on the type of activities carried out, the nature of services offered and the type of operators involved.
Real Estate Development, which concerns the initial phase of a real estate project, ranging from the assessment of the investment, identification of the area to be built on, the management of relations with public administrations and banks, up to the construction of the property.
Real Estate Management, which encompasses all of the activities involved in managing a real estate asset that include:
- building management, routine or extraordinary maintenance of the asset;
- facility management, the management of cleaning, concierge and internal security services and, in general, services that meet the needs of the building's users;
- property management, the management of economic and administrative relationships, such as rent collection, insurance payments, accounting, etc., on behalf of the property.
Asset Management, which concerns the professional management of real estate assets aimed at enhancing and optimizing its profitability through purchase, sale, divestment, restructuring or conversion operations.
REAL ESTATE: TYPE OF OPERATIONS CONSIDERED
The Financial Transactions considered are:
- Return and Risk of a Real Estate Investment: which includes all those economic and financial analysis operations aimed at assessing the real return on investment (NPV, IRR) considering all the context variables and related risks
- Enhancement and optimization of a Real estate asset: which includes all those economic and financial analysis operations aimed at enhancing and optimizing the profitability of the asset, through purchase, sale, divestment, restructuring or conversion operations.
- Better balance of costs and revenues: in Real Estate Management, to obtain the optimal return from the management of assets considering all the contextual variables and related risks and the correct sizing of the sources of coverage.
Real Estate in Italy:
"Real Estate" in Italy suffers from a still extremely backward approach, mainly economic, in which investments, costs incurred and revenues are listed and then used to evaluate the sustainability, profitability and therefore the feasibility or otherwise of the investment, through the forecast profit (incorrect) and ROI.
The financial part is only mentioned in a summary and passive way, considering only the amount of the possible loan provided by the banks, immediately and not negotiated, highlighted in the instalment of the possible pre-amortization and amortization of the capital share plus interest.
The systemic part, on the other hand, which concerns the context variables such as: the fiscal part, the macroeconomic part, the analyses of the stakeholders and possible risks, which may intervene on the investment, in the different possible scenarios, is not considered.
The result a completely unreliable sustainability and reliability forecast.
Is this approach still possible for a Real and Sustainable Economy?
This fundamentally flawed approach was sustained over time by the continued growth of the real estate market, which allowed it to mediate and compensate for all errors in predictive investment valuation.
In fact, today, this is no longer possible and if you wish to remain competitive, you have to change your method, on pain of: non-sustainability, possible financial default, etc. This thesis is supported by Joseph Stiglitz and now by over 60% of the American Real Estate Community, starting with the CEO of Black Rock.
The correct approach is the Systemic Economic-Financial one, which consists of evaluating the sustainability and profitability of an investment over time, in a correct and predictive way, taking into account the economic part (the correct investment amounts, revenues and costs), the financial part (the economic variables over time with the related payment and collection dates, the possible forms of financing) and the systemic part (the fiscal part, the macroeconomic part, stakeholder analysis and risk analysis).
This is the correct approach to allow the entrepreneur/investor to put his business ideas into practice, for a correct analysis of the investments in terms of sustainability and profitability (NPV and IRR shareholder). Obviously, to do this you need a suitable information system that allows this.
What are the IT tools used in Real Estate?
The main computer systems used in the industry are:
In Real Estate Development and in Asset Manager the tool adopted for predictive analysis and verification of sustainability and profitability of a real estate investment has been the spreadsheet for about 30 years, with all the conceptual limitations, which make it unreliable for such complex and systematic analysis as the evaluation of an investment. We will see in detail the reasons why. Let's specify, however, from the outset, that the Excel spreadsheet is not even considered to be an information system.
Management Information Systems
In Real Estate Management there are various management information system solutions, the classic ERP, which have the main function of summarizing the economic data aimed at the General Accounting (Profit and Loss Account and Balance Sheet) and in the most advanced cases include management control. The financial part, in the most advanced cases, is relegated to treasury, but almost never includes management of cash flow.
However, traditional Information systems are far from being able to support the entrepreneur/investor in his predictive economic and financial choices.
Business Intelligence can be used to integrate information systems to simulate financial projections. The limitations of this type of approach, however, are as follows:
- It starts from a detailed approach to the final balance (with some logics), to arrive at a predictive system (with other logics) and therefore inconsistent
- The Business Intelligence Systems are very effective in establishing the relationship logic between the data, but are not able to be programmed to set complex predictive projection algorithms for the same
- The limited programming falls however within a concept of subjectivity that becomes the limit for systems that must provide for the sustainability and profitability of hundreds or millions of euros, therefore they become bearers of too high a degree of risk, in the head of the subject who has made them
- They also lack the concept of certification of algorithms used by institutional sources
- However, it allows a very limited degree of approximation of the financial economic reality, around 10-15%, therefore unreliable.
The Excel spreadsheet is still the most used tool to make financial simulations in "Real Estate".
THE LIMITS OF EXCEL SPREADSHEET TECHNOLOGY
However, the Excel spreadsheet is still an adequate tool for a reliable predictive analysis in "Real Estate" operations in a modern economy
What is the reliability of the Business Plan made with an Excel spreadsheet, on which the investor must decide investments of hundreds, thousands, millions of euros?
Unfortunately, the answer is no, as the average reliability of any Business Plan made with Excel spreadsheets technology, regardless of the skill of the analyst who made it, is on average 15-20%!
Let's see the reasons, discovering that, in addition to the lack of Reliability, there is also a lack of Opportunity and Profitability for investments managed with Business Plans made with Excel.
LACK OF RELIABILITY
The average reliability of a Business Plan created using Excel spreadsheet technology, irrespective of the competence of the analyst preparing it, has been measured on a large number of BPs drawn up and was found to be in the average range of 15-20%.
An approximation of about 20%, in the best case scenario, means that each result obtained has a reliability of 20% or, in other words, has a margin of error equal to its complement, i.e. 80%. This means, for example, that a Cash Flow value of €1,000,000, calculated in this way, ranges from a value of €1,000,000+/- 800,000, i.e. €200,000 to €1,800,000.
This type of approximation highlights a problem of reliability of the calculated value, but even more so of precariousness in referring to the Business model, to make entrepreneurial decisions that have an economic and financial impact on the same.
Let's see the structural reasons for the inadequacy of an Excel Spreadsheet due to the limited opportunities it can offer in the management of the various "Real Estate" operations:
of Business Plans is one of the most unmistakable causes of unreliability, for these reasons:
Cash that is always positive, on an annual basis, may, in fact, turn out to be negative for most months with the need to cover it with Bank Lines or a capital increase. The NPV values obtained are therefore unreliable.
An annual-based cash flow prevents visualization of tax payments, preventing evidence of critical liquidity issues, which become essential to obtain preventive financial coverage.
LACK OF A SYSTEMATIC APPROACH:
due to the inability of Excel spreadsheet technology to take into account all the variables inherent in a given context such as, for example:
The VAT rates associated with each variable that enters the model.
The different tax rates
Risk variables, not taken into due consideration.
VAT MANAGEMENT PROBLEM:
is in most Business Plans handled incorrectly or insufficiently, due to the inability of Excel technology to take it into account.
In a real estate development project, relating to the construction of two buildings, characterized by an investment of 20 million Euro, the incorrect management of VAT refunds and vertical compensation caused a serious financial imbalance that forced the owner to sell part of the control package of the company to another investor, who took over to smooth out the financial situation.
VAT then pays particular attention to investments in the management of deposits and down payments. In many of the projects reviewed it is not considered with the result of erroneous cash flows.
WORKING CAPITAL PROBLEM (DUE TO DIFFERENCES BETWEEN PAYMENT AND COLLECTION DAYS):
in most cases the Business Model is ignored not for competence problems, but due to the impossibility of managing it on an annual and not monthly basis.
In a real estate development of 5 Mil. € 700.00 in circulation was neglected, needless to say the damage it caused to the entrepreneur.
PROBLEM OF COMPROMISES, DOWN PAYMENTS AND DEEDS:
This is a complex collection method, characteristic of Real Estate projects, which must be managed on a monthly basis and correctly take into account VAT flows.
In a real estate development project, the semi-annual management of these arrangements led to an inaccurate situation that caused the contractor to manage the situation in great distress.
PROBLEM OF THE LACK OF CERTIFICATION OF THE ALGORITHMS USED:
due to the lack of reference to sources declaring their correctness, which is an important element that every Investor should require. Certification is required for wine, for oil, but not for BPs, which decide on the analysis of investments or strategies worth millions of euros.
In a Due Diligence performed by an Investor who was to acquire a real estate holding, the counterparty was asked what algorithms were used and by whom they had been certified. It turned out that different algorithms were used for the same function and, moreover, when asked what the sources were, the answer was: the experience of the person who had drawn up the Business Plan. Of course, the deal was off.
COMPLEXITY-RELATED ERROR PROBLEM:
due to the fact that the more complete you make the BP model on the Excel sheet, the more the probability of error (of formula, of not connected cell, of calculation, etc.) increases, making the results unreliable.
Two well-known professors at MIT drafted the three-year works plan for a major government department. Unfortunately, a university student of MIT, after a few months, disavowed the BP / PEF for having found a calculation error, trivial, but such as to make the obtained calculations unreliable, also with serious damage to the image of the Government and the two distinguished professors.
THEREFORE, THE "EXCEL SHEET", TO MAKE BUSINESS PLANS FOR "REAL ESTATE" OPERATIONS, IS THE FIRST RISK, EVALUATED AT AROUND 80-85%.
For further details you can go to the chapter "Platform"
LACK OF OPPORTUNITY
The possibility to manage the different cases that a Business Model can offer in a flexible manner, is very limited with Excel spreadsheet technology, as this technology does allow models to be developed that can thoroughly simulate the different economic and financial aspects of reality.
In fact, to reproduce the different assumptions on Excel soreadsheets, means re-customizing the model each time, with consequent time-wasting, making operativity impossible.
However, not managing them means not being able to translate the entrepreneur's ideas into reliable financial economic data to find the best solution.
What does this limit mean for the investor? It means making them lose Business Opportunities that can range from a few thousand to millions of Euros.
Let's look at the structural reasons for the inadequacy of the Excel Spreadsheet due to the limited number of Opportunities it can offer in the drafting of a Business Plan:
DIFFICULTY/IMPOSSIBILITY IN BREAKING DOWN A BUSINESS MODEL INTO ITS BUSINESS UNITS
due to the complexity that would be induced in the Excel model to handle them. In fact, the Business Unit represents the minimum unit of analysis with its investments, costs and operating revenues, used to break down the company model into its operating divisions in order to allow the entrepreneur to decide priorities in investments, on which business units to focus attention and operate.
A real estate development related to the construction of three towers, examined with the classic spreadsheet technology, with a single business unit, obviously due to the complexity of representing this type of problem on an Excel spreadsheet, turned out to be completely unfavorable for the entrepreneur who found himself sustaining an investment Equity and a line of Bank Debt almost double that of the correct simulation which considered the three Business Units and which used monthly analysis and relative self-financing.
DIFFICULTY/IMPOSSIBILITY OF ANALYSING A BUSINESS MODEL IN ITS VARIOUS SCENARIOS
based on the different assumptions, having to work on the formulas which is time consuming and increases the possibility of errors.
A real estate development project is very sensitive to the risk analyses that must be provided for in the various scenarios in order to verify the economic and financial situations occurring and at the same time understand what actions to take in advance, rather than finding oneself managing them suddenly with all the consequences of the case.
DIFFICULTY IN EXAMINING COMPLEX OPERATIONS
which, with Excel spreadsheet technology, would become so approximate as to be unreliable.
A complex real estate operation of 40 million euros, located in Austria, studied by an American investment fund, with two analysts, one based in New York and the other in India, obtained the approval of financing from the banks in about two weeks, using "Finance Atena", compared to the previous six months that they had tried to obtain in vain using spreadsheet technology.
due to the fact that in the BP created using spreadsheets, the data are wired with formulas and therefore only the person who has drawn up the Economic Financial Plan can work on it with all imaginable limits and cannot delegate to other departments.
In acquisition processes, time is of the essence and therefore having delegated possibilities of loading data into the analysis model becomes important.
LACK OF PROFITABILITY
The Business Plan (BP) of a Private Equity financial operation drawn up using a spreadsheet, besides having a Reliability of 15-20% and therefore not significant to seriously analyze a financial operation of hundreds/millions of euro, of great impact on the investor, presents this recurring issue:
OVERESTIMATION OF SOURCES TO COVER INVESTMENTS (EQUITY, BANK LINES, SHAREHOLDER FINANCING)
due to Excel technology, because it does not allow financial optimization of cash flows, which is instead possible by breaking down the Company Model into Business Units, by managing flows on a monthly basis and by managing self-financing, which is too complex to reproduce using Excel technology. This causes an investor to waste useful capital that he could use in other ventures and also reduces the project’s profitability, decreasing the shareholder NPV.
In a project of an important real estate development involving an investment of about 50 million euros, analysis of the sources to cover the investments, calculated using the classic business plan in Excel, resulted in 25 million for the bank line and 18 million for the shareholder line of financing, when reworking using Finance Atena technology resulted in a Bank Line of 16 million euros and 12 million of shareholder financing with an overall saving of 14 million.
SUSTAINABILITY IS ALWAYS CRITICAL
presenting negative cash flows on which the IRR and the NPV are calculated, when in fact it becomes conceptually impossible to do so, because the cash flow, due to the principle of financial sustainability, must always be positive and to do this debt or equity lines must be provided, which generate a debt service that must be taken into account in the calculation of the profitability parameters. The reasons for these results are mainly due to the fact that a predictive financial economic analysis is a very complex analysis and it is inadequate to try to translate it on an Excel spreadsheet due to its structural limitations, due to the problem posed.
Sustainability on an annual basis is critical in most cases as it does not take into account cash flows on a monthly basis, creating unrealistic expectations and, ignoring the necessary hedges, leading to an underestimation of the debt.
due to Excel technology that easily leads to calculating NPV and IRR values, but which are unfortunately unreliable, as the real problem is to calculate correct cash flows. Precisely for this reason, the values obtained never correspond to reality, constituting a problem for everyone, first and foremost for the investor.
Profitability is always overestimated compared to the reality of the facts, ignoring taxes, ignoring the correct method of payment, cash coverage, always disappointing the expectations of the investor who pronounces the fateful phrase at the end of the operation: "I thought I would earn more, or, the accounts don’t add up, etc..